2012 Practical Tax Planning: Retirement
Your retirement plans and IRAs may be among the largest, if not the largest, asset that you have. Understanding the basic tax rules and then planning your distributions to meet your personal financial and estate planning objectives is essential. We can explain those rules and provide some strategies for you to consider as part of your overall tax plan.
Get Your 2012 Retirement Plan Deduction Set Up. First, a question: is your or your corporation’s retirement plan in place as you read this? If not, and if you have some cash you can put into a retirement plan, get busy and put that retirement plan in place so you can obtain a tax deduction for 2012. The tax code provides significant incentives for individuals to make contributions to retirement savings and plans, including traditional and Roth IRA’s, as well as to employer sponsored qualified and non-qualified plans, including qualified 401(k) plans. A saver’s credit also may be available for investors in certain tax brackets, which further enhances overall savings.
Convert to a Roth IRA. Consider converting your 401(k) or traditional IRA to a Roth IRA. When you put money into a Roth IRA, you don’t get a tax deduction. That’s bad. But the money you put in grows tax-free and it never gets taxed again (providing you don’t violate the rules). If you make good money on your IRA investments, the Roth is far superior to the traditional retirement plan. And this might be a good year to make the Roth conversion. Tax rates are low.
But even with low tax rates, you might have no taxes. Ask yourself: what is my tax basis in my 401(k) or traditional IRA? If it’s about equal to what’s sitting in the account now, you can convert with no or very low taxes on the conversion. Here are just a few other advantages of a ROTH over a traditional IRA:
- If you don’t convert, you could owe big taxes on your future withdrawals.
- If you die and leave a traditional IRA to your heirs, they could owe big taxes when they take the money from the inherited IRA.
- If you convert, you need to leave the new Roth IRA untapped for five years.
- You can contribute to a Roth IRA after age 70 1/2.
Make Proper Distributions. Some taxpayers may consider early retirement as a viable option. However, generally, a distribution made before you are 59 ½ years of age is subject to a 10% penalty in addition to the tax otherwise payable on the distribution. There are some exceptions. The penalty may not apply for certain hardship cases, for first-time home buyers, or to pay certain medical or education expenses. Many distributions may be received tax free if they are transferred to an IRA or another eligible plan within 60 days of the distribution.
Though there is a penalty for premature distributions, there is also a penalty for failure to commence distributions by a certain age. Minimum distribution rules are imposed to prevent participants from unreasonably deferring the tax on their retirement savings. Under these rules, distributions are required to begin, for a participant other than a 5-percent owner, no later than April 1 of the calendar year following the later of:
- the calendar year in which the participant reaches age 70 ½, or
- the calendar year in which the participant retires.
The minimum distribution rules do not apply to Roth IRA’s, but do apply to traditional IRAs, deferred compensation plans, tax sheltered annuities, and qualified retirement plans